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Economics focus: three things to watch in 2017

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How much will the economy slow this year? That largely depends on three factors: the strength or otherwise of business investment; whether firms continue to recruit; and whether households faced with an income squeeze keep spending. Nothing is certain, but all three point to more subdued growth in 2017 and beyond.

After all the excitement of last year, it is just possible that more of our attention in 2017 will be directed elsewhere. True, there is still the tricky task of beginning the process of Britain’s departure from the European Union, with the triggering of article 50, and recent events have underlined what a difficult and delicate task will be.
Inevitably, though, much of the world’s attention will be on Washington, or perhaps Trump Tower in New York, to see how what is already shaping up as the strangest modern day US presidency evolves. So far, financial markets are assuming President Trump will be good for the US economy and have even taken in their stride warnings from the Federal Reserve, the US central bank, of a faster pace of interest rate rises.
When Trump’s tweets are not demanding attention, events in Europe will be. The test, in elections in the Netherlands, France and Germany, will be whether the new politics we saw last year has crossed the Atlantic, and the English Channel, into mainland Europe. We can certainly expect something different, though I would be very surprised if elections moved any of these three countries towards the EU exit door. Brexit will, I think, remain a special case.
Closer to home, what kind of British economy can we expect in 2017? Fears of a sharp slowdown in activity after the Brexit vote proved largely unfounded. Some of those fears, and forecasts, emerged after the result. When the Bank of England cut interest rates in August, it did so in the expectation that growth in the July–September quarter would be just 0.1%. In the event, it was 0.6%.
As Andy Haldane, its chief economists, reminded us recently, economists have not been good at predicting the impact of these big changes, having had a ‘Michael Fish moment’ when the financial hurricane hit in 2008, and an echo of one in dealing with the short-term economic impact of the Brexit vote and Trump’s election victory. In Haldane’s position, I might have been inclined to point out that perhaps the Bank’s emergency rate cut had a bigger impact on the economy than it had hoped.
The upshot is that we enter 2017 with the economy growing significantly faster than expected. Momentum is important, and Britain has it. Purchasing managers’ surveys for the manufacturing, construction and service sectors, covering December, were all at their highest for many months. Business confidence appears to be quite high, given the uncertainty.
This is important, for what businesses do in 2017 is one of the keys to the outlook. There are three things we should look out for this year. The first is the extent to which businesses, uncertain about prospects and our relationship with the EU, cut back on investment. Business investment, which fell in 2016 judging by the figures for the first three quarters of the year, is closely correlated with uncertainty. The greater the uncertainty, the weaker the investment outlook. The key question, then, is whether buoyant activity late in 2016, coupled with high levels of confidence among firms, overcomes these uncertainty effects and encourages businesses to keep on investing. The jury is still out.
The second, and related, issue also applies to firms and is the question of whether they will maintain or increase employment. One of the fears leading up to the referendum was that there would be an increase in unemployment, as businesses put recruitment on hold and adopted a more cautious approach. Again, it is not certain how this will play out. Surveys suggest that employment intentions remain positive, but official figures pointed clearly to an employment slowdown in the second half of last year. The Office for National Statistics reported that the employment rate, which remains close to record highs, slipped to 74.4% towards the end of last year, and that employment growth flattened out. Forecasters think this is the shape of things to come. Most think that unemployment will be higher, by 200,000 or so, by the end of the year. That would be bad news but it is relatively mild in comparison with past episodes.
How much unemployment does go up depends on the third factor: the extent to which consumers will rein back in response to the squeeze on their incomes arising from rising inflation. Inflation, just over 1% as I write this, is set to climb to around 3% by the end of the year, largely because of the pound’s sharp post-referendum fall. With pay growth stuck at 2.5% at best, this implies a drop in real incomes. Last time there was such a squeeze, the Labour party made hay with what it called a cost of living crisis, and consumer spending was weak.
The question this time is whether households will try to spend their way through this spike in inflation, perhaps by borrowing. Already a head of steam has built up in consumer credit, which is growing by 10.8%, its fastest since before the financial crisis. Normally, consumers borrow to supplement income growth, not replace it. We shall see whether that is true this year.

What does all this add up to?

Despite the economy’s end of 2016 momentum, the expectation among economists is that growth will slow to between 1% and 1.5% this year, and probably remain subdued for the following two years. That will make it harder for Philip Hammond to meet even his softer deficit reduction targets. It will also provide a challenging backdrop for Britain’s tricky Brexit negotiations.
Forecasters, of course, are far from infallible, as most of them would readily concede. It may be that the resilience the economy has shown so far will persist. It may be that companies and households will not be as troubled by Brexit and other uncertainties as is feared. That, at least, has to be the hope. Otherwise, it could be a tough time. 
Categories: Analysis , In brief